In yesterday’s post, I identified a number of problems with
our current system for financing higher education, and I promised that I would
suggest a new approach.

The option I think we should strongly consider is to ensure
that every American can finance college or graduate-school tuition (or the cost
of job training) with a special income-contingent federal loan. The loan would have an extended term (up to
30 years, like a mortgage) and would defer or potentially forgive interest
payments for any year in which the recipient’s household income fell below a
pre-specified trigger.

Income-contingent
lending for education is certainly not a new idea. In the past, its intellectual champions
included both Milton Friedman and James Tobin, two Nobel laureates in economics
from opposite ends of the political spectrum. Among politicians, key supporters have included Congressman Thomas
Petri, Republican from Wisconsin, and former
Senator Bill Bradley, Democrat from New Jersey. The
idea has broad appeal because it addresses an important weakness in our market
system.

Just as limited
liability law encourages investment in financial capital, an income-contingent-loan
program would encourage investment in human capital by limiting the investor’s
downside risk. In my view, it would
represent a vital – and ultimately self-financing – policy innovation for the
information age.

A New Approach to Financing Post-Secondary Education

An
income-contingent-lending (ICL) program, underwritten and administered by the
federal government, would help to address all of the problems I identified
yesterday and would offer many other advantages as well. The key benefits would include: access for all students, fairness for students and families, efficiency in administration, and
increased productivity for the nation
as a whole.

Access for All

Most importantly, a
federal ICL program would ensure that every
American could attend college (or any other form of post-secondary education),
based solely on merit and irrespective of need. Many parents would still save to help cover tuition, but they could rest
assured that adequate financing would be available even if their savings fell
short. And the financing – in the form
of income-contingent loans – would involve dramatically less risk for their
kids than traditional student loans. Although participating students would assume substantial levels of debt,
they would have much less cause for worry, since they would not have to pay in
any years in which their income faltered.

 

Fairness for Students and Families

In terms of fairness,
income-contingent lending would offer a much better way of addressing
need. Carol, who earned a high income
after college, would be required to cover the total cost of her education (by
repaying her loan in full); whereas Bill, who earned a much lower income after
college (because, for example, he chose a career as a public school teacher),
would get a break, though only for as long as his income remained low. With income-contingent loans, borrowers would
also gain much needed leeway in the face of life’s unpredictable hazards, such
as unemployment, serious illness, or natural disaster.

 

Efficient Administration

An ICL program would
also make good sense from an administrative standpoint. Under the current regime, about
three-quarters of all loans for post-secondary education are guaranteed by the
federal government. For the most part,
private lenders earn profit when the loans are repaid (as they are in the vast
majority of cases), and the federal government is left holding the bag when
they are not. In addition, the federal
government often pays dearly for private collection services, which are frequently
provided by the same lenders whose “losses” were already fully covered by
federal guarantees. Although the
question of direct versus guaranteed student loans remains controversial,
numerous experts believe that the government’s direct lending programs are more efficient.

Under an ICL program, in
which the federal government would lend directly to students, collection could
be administered through the IRS, as part of the normal withholding system. Since repayment would be virtually automatic
in most cases, delinquency would be reduced to an absolute minimum, which in
turn would ensure the lowest possible interest rates on the loans themselves.

Clearly, the federal
government would face sizable start-up costs, once it began issuing the new
loans. Ultimately, however, as the loans
were repaid, the program would become self-financing – apart from the funds
necessary to cover interest deferrals and forgiveness for borrowers whose
incomes fell below the trigger.

 

Increased Productivity

One final benefit is
that by encouraging additional investment in human capital, an ICL program
could help to raise national productivity. This would boost GDP, household incomes, and government revenues. Given the high returns on education in the
information age, the program could, over the long term, pay for itself many
times over.

** ** **

In my next post, I’ll explore precedents for an
income-contingent lending program, both at home and abroad.